Why Do Some Companies Leave? Evidence on the Factors that Drive Inversions

Douglas O. Cook is the Ehney A. Camp, Jr. Endowed Chair of Finance and Investments at the University of Alabama. Joseph Stover is a Visiting Assistant Professor of Finance at Trinity University. This post is based on their recent paper.

On November 23rd, 2015, pharmaceutical giant, Pfizer, officially announced that it had reached an agreement with its competitor, Allergan, to merge the two companies in a deal that would have created the largest pharmaceutical company in the world. The combined company would have been called Pfizer and would have been led by Pfizer’s current CEO, Ian Read, but the deal was being structured so that, at least on paper, Allergan would have been the buyer. By making Allergan the purchaser, Pfizer would be able to change its country of incorporation from the U.S. to Ireland (where Allergan is currently incorporated) and reduce its tax bill in the process.

Very few people outside of the board rooms and executive offices of Pfizer and Allergan seemed to like the deal, although there was stark disagreement about where to place the blame. Many, primarily on the “right”, blamed the US tax code, which has the highest statutory rate in the developed world and is also one of the few tax codes that taxes its companies’ foreign earnings when they are brought into the country. Others, primarily on the “left”, blamed Pfizer for trying to skip out on its tax bill, arguing that Pfizer had benefited from being a U.S. company and that it should be willing to pay its fair share especially considering that it had earned over $9 billion in profits the previous year.

The CEOs of the two companies tried to sell the deal to the public by publishing an editorial in USA Today called “Pfizer-Allergan: Good for America”, where they wrote “There is a myth that we are skirting U.S. taxes. Not true.” [1] Despite the assurances that the deal was not about reducing its tax bill, Pfizer cancelled the merger just two days after the U.S. Department of the Treasury issued several new regulations [2] to close some of the tax loopholes that Pfizer was planning to utilize.

While Pfizer would have been the largest company to ever leave the U.S. to reduce its tax bill, it hardly would have been the first. In fact, since the early to mid nineties there has been a wave of companies following this strategy which is known as a corporate inversion. [3] Inversions started receiving a lot of media attention in 2014, during a period when several large companies were considering them. Since that time, politicians have been working corporate inversions into their talking points and promising to close the loopholes and prevent these companies from “deserting their country.” Other politicians have argued that closing loopholes won’t be enough, and that companies will just become more creative in how they structure these deals. According to these people, the only way to keep companies from leaving is to overhaul the U.S. tax system and make it more attractive for companies to be here. In lieu of congressional action, the U.S. Department of the Treasury has announced new regulatory guidelines three times since 2014 to try to deter U.S. companies from inverting. [4] While the most recent Treasury actions proved effective at derailing the Pfizer-Allergan merger, the previous two announcements seemed to be much less effective. For instance, the Pfizer-Allergan merger, was announced just four days after the Treasury Department issued their previous anti-inversion guidelines in November 2015.

There is already a small and growing literature on corporate inversions which we contribute to by investigating the factors that influence a company’s decision to invert as well as some of the costs and benefits. We start by presenting our data and showing how inversions are clustered by industry and by the methods that companies use to invert. We also provide details on how we classify different inversions and examples to help clarify the different ways a company can invert.

Next, we investigate the way taxes and tax avoidance are related to inversions. We find, inconsistent with common public assumptions but consistent with the notion that inversions are one element in a company’s tax aggressiveness strategy, that after controlling for other factors, companies with lower effective tax rates are more likely to invert. In fact, industries with lower average effective tax rates have a significantly higher number of inversions. We also find that other measures of tax aggressiveness, particularly larger permanent book-tax difference are significantly predictive of inversion activity, and that there are more inversions in industries with higher levels of competition.

We also examine the effect inversions have on a company’s effective tax rate. We find that, following an inversion, a company’s effective tax rate drops by a statistically and economically significant 3.1 to 5.5 percentage points depending on the measure of effective tax rate and data selection. This drop is present even after controlling for the downward linear trend identified by Dyreng, Hanlon, Maydew, & Thornock (2017) [5]. We think this result is particularly interesting in light of their results because they find that the overall downward trend in effective tax rates cannot be explained by an advantage for foreign companies or multinationals. By identifying a drop in effective tax rate following an inversion we provide a specific instance where the international activities of a company result in the company lowering its effective tax rate from one year to the next.

We also examine a number of board and CEO characteristics that could predict inversions. On the board side we look at the number of politically connected board members (following Kostovetsky (2015)) [6] and measures that may be proxies for patriotism or conservative policies; e.g. the number of board members with government service, the number of board members with military service and the number of female board members. As expected we find that the latter three measures are all negatively related to the probability of an inversion, although the effect is stronger in boards that have three or more members in the category. On the CEO front we look at CEO age, two measures of overconfidence, and the percent of the company owned by the CEO, and find that none of these measures is significantly related to inversions.

Finally, to investigate a potential cost of inversions, namely whether political rhetoric can harm inverters, we look at the market adjusted returns for inverters surrounding a speech given by president Obama that criticized inverters and promised to close loopholes to make inversions less attractive. We do not observe a sharp drop in market adjusted returns on the day of the speech, but we do find a negative cumulative return for the full event window that is significant at the 1% level.

The complete paper is available for download here.


1https://www.usatoday.com/story/opinion/2015/12/01/pfizer-allergan-ian-read-brent-saunders-editorials-debates/76627152/(go back)

2 https://www.treasury.gov/press-center/press-releases/Pages/jl0404.aspx(go back)

3 Some readers may note that in the most technical sense of the word, the Pfizer-Allergan merger was not an inversion because the deal was structured so that Allergan would have been officially the buyer. In this paper we ignore such technicalities and use the term inversion to describe any corporate action that makes a U.S. company foreign in a legal sense to reduce its tax burden. This is consistent with the term’s common usage.(go back)

4 In addition to the Announcement on April 4th, 2016 that curbed the Pfizer deal the treasury also released guidelines on September 22nd, 2014 and November 19th, 2015 which can be found at https://www.treasury.gov/press-center/press-releases/Pages/jl2645.aspx and https://www.treasury.gov/press-center/press-releases/Pages/jl0281.aspx respectively.(go back)

5 Dyreng, S. D., Hanlon, M., Maydew, E. L., & Thornock, J. R. (2017). Changes in corporate effective tax rates over the past twenty-five years. Journal of Financial Economics, 124/(3), 441-463.(go back)

6 Kostovetsky, L. (2015). Political capital and moral hazard. Journal of Financial Economics, 116/(1), 144–159.(go back)

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